It seemed like a match made in high-tech heaven. Nest Labs
was hatched in 2010 in a Palo Alto, California, garage by Tony
Fadell, a former Apple executive who played key roles in
developing the iPod and the iPhone. Fadells notion of the
next big thing was an intelligent, communicative thermostat
that could launch the era of the so-called smart home. He
quickly gathered angel funding, led by legendary Silicon Valley
venture capital firm Kleiner Perkins Caufield & Byers. In
2014 the investors sold Nest to Google for a cool $3.2
billion.

We felt it was a fair price because Google was getting
arguably the best hardware team on the planet at the
time, says Rob Coneybeer, co-founder of Shasta Ventures,
which joined Kleiner Perkins in Nests A-round
funding.

Marrying that team to Googles networking dominance and
enormous financial resources to redesign the way we all live
 what could go wrong? A lot, it turns out. Fadell, an
alpha executive who acknowledged to the New York Times
that he pushes people beyond what they thought they could
achieve, had an ugly public spat with one key
subordinate, then semipublic friction with a new chief
financial officer at Google (formally renamed Alphabet Inc.),
who pressed him to shorten Nests so-called runway to
profitability. Two years after the acquisition, he was ready to
quit. He left the company in June.

Meanwhile, Nest experienced bugs in its second big
product, a smoke detector that had to be recalled when
regulators found it could be disabled accidentally. While the
first mover stumbled, competitors including Amazon.com, Apple
and Samsung Electronics Co. woke up to the potential of the
smart home. The current consensus among the technorati is that
Amazon has jumped ahead in this potential multibillion-dollar
market by inviting the outside world to build hardware around
its Alexa voice-command system.

The market is still in a very nascent and fragmented
state, but Amazon is the dominant player today, says
Werner Goertz, who covers personal technology for tech
consulting firm Gartner.

Nest and its parent, Alphabet, are hardly out of the running
on the smart home. But Nests tumultuous first six years
are a cautionary tale for institutional investors seeking
return from unfolding technological wonders. While Silicon
Valley remains a seemingly inexhaustible well of innovation and
implementation, portfolio investors struggle to catch the
lightning of that innovation in a bottle of stable
profitability, whether directly through innovators share
offerings or indirectly through acquisition by existing public
companies like Alphabet. There are so many ways for the
brightest to stumble  through the vagaries of
visionaries egos, the relentless efforts of rival
geniuses, or simple wrong guesses in an endlessly evolving
domain.

Venture capitalists can live with multiple failures thanks
to the huge killings they make from their successes.
Institutional investors, which access companies later in their
development cycles, cannot. The economics of my business
allow me to succeed less than 20 percent of the time and still
deliver extraordinary returns, says Randy Komisar, the
Kleiner Perkins partner who oversaw his firms stake in
Nest. Investors in public markets just cant afford
that.

Kleiner
Perkins was the first and largest private investor in Nest,
but Komisar admits to being a bit underwhelmed when Tony Fadell
first pitched him. After the iPod and iPhone, I thought
he could do very grand things, he says. When he
presented a round thermostat, I was a bit
disappointed.

By 2010, Fadell, now 47, had a reputation as one of the
Valleys most potent secret weapons. Raised outside
Detroit, he had headed west after graduating from the
University of Michigan in 1991 with a computer engineering
degree. Fadell got a job at General Magic, a wireless
communications pioneer founded by renegade Apple engineers. His
colleagues there included established tech legends like Andy
Hertzfeld, a founding father of the Macintosh personal
computer, and legends-to-be like Pierre Omidyar, who not long
afterward started eBay.

Tony was a leader fresh out of undergrad,
recalls Peter Nieh, another General Magic alumnus, who two
decades later invested in Nest as a partner at Lightspeed
Venture Partners. He was an incredible engineer combined
with a provocative thinker. If Tony was starting a company to
do food trucks, we would have backed him. Fadell himself
declined to be interviewed for this article.

Fadell left General Magic after its 1995 IPO but continued
to focus on the budding field of networked devices. He created
a business unit to focus on palmtop computers for Dutch
electronics giant Philips, then in 1999 formed a company called
Fuse. There he tinkered with a portable digital music player to
capitalize on the burgeoning MP3 file-sharing movement.
(Free-music pioneer Napster launched that same year.) Fuse
failed to raise sufficient venture capital funding but found a
home within Apple, where Steve Jobs made Fadell chief of the
iPod group in 2001.

Over the next seven years, Fadell proved his mettle at Apple
as both an innovator and an administrator, overseeing massive
hardware development efforts for the iPod and early generations
of the iPhone.

I saw Tony drive teams on time and on budget over very
tight schedules for dozens of product versions, Komisar
says. The work he did at Apple was critical in
transforming it from a computer maker to a consumer products
company.

At Nest, Fadell soon convinced Komisar and his other
investors that his little round thermostat held the seeds of
another lucrative revolution. It was a Trojan
horse, in Komisars phrase, for a rethinking of the
worlds living spaces, spurred by cutting-edge artificial
intelligence and networking science. Smart home is the domestic
front of the much-touted Internet of Things (IoT). Sensors that
allow inanimate objects to see what is around them, machine
learning algorithms that teach them how to sort out what they
see, and communications links to other, similarly clever
objects  all are supposed to be hurtling us toward a
world of self-repairing cars and factory-floor robots that
order their own inventory, to name two examples.

Some early smart-home products may seem whimsical, like the
Samsung Family Hub fridge  unveiled this year and priced
at $5,000  that can report remotely when its owner is
running low on milk. But an intelligent thermostat like
Nests can have a significant, immediate impact on energy
use and costs. The devices sensors can, among other
abilities, correct for the effect of winter sunlight warming a
thermostat while the rest of the house stays cold. Constant
communication with a utilitys computers allows the
homeowner to draw energy in cheaper, off-peak periods and save
it for the peaks.

Fadell leveraged his Apple experience to make his device
simple and attractive, well aware that 90 percent of homeowners
do not bother to program their thermostats because the process
is too complicated. Tony and his team had a complete,
maniacal focus on this single product, investor Coneybeer
says. They bought hundreds of thermostats and put them up
on a fake wall in the office. They spent hundreds of hours
visiting people in their houses to see where the thermostats
hung.

Still, the real promise of Nest was the opportunity to set
the protocols and standards that future smart-home inventions
would conform to, as the iPhone did for the universe of mobile
apps. Some of those applications are envisioned but not yet
developed, Gartners Goertz says. These include
smart-sprinkler systems that integrate soil moisture readings
and weather forecasts to irrigate the garden more efficiently,
and monitors for the elderly that can call for help if the
wearers blood pressure spikes or they take a fall. Other
innovations presumably remain unforeseen  as Fadell
himself could not have foreseen Uber Technologies when he was
helping to create the iPhone in the mid-2000s.

Nest started with a clear head start as the hub of this
far-­reaching ecosystem. Its 20th-century
thinking that youre investing in companies and their
products, says Michael Schrage, an author on innovation
and a research fellow at the MIT Center for Digital Business.
What youre investing in now is great
platforms.

Fadell and his junior partner, Matt Rogers, who had worked
on his team at Apple, did not let their venture capital
investors down. Though sales figures remain confidential, the
Nest thermostat moved out of the garage and into mass
production by October 2011, and by now it is an established
fixture on hardware store shelves. A second product, the Nest
Protect smoke and carbon monoxide alarm, rolled out in October
2013. (One nifty feature: It shuts down its homes boiler
and furnace in the event of a perceived fire.) They were
performing like a Swiss clock, Komisar recalls.
This was one of the fastest-growing product companies we
ever had at Kleiner Perkins.

Nest was not shopping for a buyer, Komisar and other
investors say. But Fadell had an informal bridge to Google
founders Larry Page and Sergey Brin via Bill Maris, then chief
of the companys Google Ventures investment arm, which had
taken an early stake in Nest. The high-powered trio began to
schmooze periodically as Nest tested its market muscles. Buyout
talks heated up toward the end of 2013.

Despite the $3.2 billion enticement, Nests backers,
including Maris, say they had serious qualms about selling.
I thought Google got a screaming deal when they got
Nest, Maris says. I would have liked to see the
company stay private. (He left Google last summer, a few
months after Fadell, claiming burnout after ten years and a
desire to spend more time with his infant son.)

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